LePage tax cut plan, based on disproven thinking, comes at a staggering price

Gov. Paul LePage wants a Maine that’s more competitive. He wants to attract more corporate investment to spark job growth. He wants to entice more people to move to Maine, and he doesn’t want Maine’s wealthiest to have a reason to decamp and declare their residency elsewhere. He wants a modern tax system for a modern age.

His primary vehicle to accomplish these goals is the tax plan that’s the key feature of his proposal for a new two-year budget. Where so many other policymakers have failed, LePage wants to succeed in shaking up a state tax structure that largely hasn’t changed for nearly 50 years and has a narrow base that makes it vulnerable to economic downturns.

The tax plan lowers individual and corporate income tax rates and, to partially make up for lost revenue, raises the sales tax and extends it to a range of services. LePage has noble goals with it: Maine’s tax system is overdue for some significant changes. Maine needs more jobs, and it needs more residents. It needs a powerful competitive advantage. But it’s doubtful LePage’s sweeping tax plan would yield any of these.

The plan relies to a dangerous extent on unproven and even disproven thinking about people and businesses’ behavior in reaction to tax policy. It relies on misconceptions about job growth and even about Maine’s tax system. While LePage’s tax plan includes a few beneficial changes, it would be unwise — indeed, dangerous — for lawmakers to enact the plan in its entirety.

The competitiveness myth: A major thrust behind the tax plan is that Maine needs a tax overhaul in order to become competitive with states that have lower individual and corporate income tax rates and, therefore, stand a better chance of attracting large businesses. Under LePage’s tax plan, Maine will have a corporate tax that makes cross-border moves compelling even for New Hampshire businesses, Jonathan LaBonte, director of the governor’s Office of Policy Management, said in a meeting with the BDN’s editorial board.

Maine’s lack of business tax competitiveness, though, is a myth. In 2011, the Council on State Taxation and the consulting firm Ernst & Young assessed effective tax rates on new business investment in each state — the opening of a call center or factory, for example — presumably an important measure for making a state attractive to relocating or expanding businesses.

Maine came out the top-ranked state, with a 3 percent effective tax rate on new business investment. Why? Not because Maine had the lowest corporate tax rate (its rates are higher than the national average) but because Maine’s corporate tax structure, unlike most other states’, allows businesses to avoid substantial tax liability if most or all of their sales take place outside of Maine. Its relatively low sales tax — which LePage proposes to raise — and property tax exemptions for business equipment also helped the ranking.

In 2013, Maine came out on top in another Council on State Taxation survey evaluating businesses’ dealings with the tax system. Maine was the only state to earn an “A” in the survey, which took into account whether states had independent tax appeals boards, whether businesses had to prepay disputed tax amounts (not in Maine) and a handful of other factors.

Clearly, even the most competitive business tax environment is no panacea. Indeed, research generally shows state and local taxes make up a small portion of all business costs — 1.8 percent across all states, according to a 2012 paper by University of Iowa economist Peter Fisher. As a result, they play a small role — if any at all — in determining where businesses set up shop. The state corporate tax is only a fraction of all other taxes, so Fisher found cutting corporate tax rates in half results in a 0.09 percent cost reduction for the average firm.

The job creation myth: A job creation strategy focused foremost on business attraction through a competitive tax code is based on another myth — that states’ job gains come primarily from business attraction. Between 1992 and 2006, states’ job gains overwhelmingly — 98.1 percent — were the result of new businesses starting within their borders and existing businesses expanding, according to a 2010 analysis by the Public Policy Institute of California. Just 1.8 percent of job gains could be attributed to relocation from other states.

The migration myth: By lowering individual income taxes and ultimately eliminating the estate tax, LePage hopes to attract new residents and keep others — particularly those with substantial assets — from leaving. But these elements in the LePage tax plan point to another myth: that taxes play a deciding role in residents’ cross-border moves.

“States raising taxes will see somewhat fewer migrants choose their state as a destination, but offset and reverse this impact when they use increased tax revenues in ways that attract people and create jobs,” it read.

LePage’s proposal to eliminate Maine’s estate tax, which currently applies to estates worth $2 million or more, stands to benefit the heirs to dozens of the wealthiest Maine households each year, whether they live in Maine or not.

Not all of those families would leave Maine if the estate tax remained, so the tax basically comes down to a tradeoff. The UMass study finds keeping the estate tax in place is the better deal: “The tax revenue lost by the states because of this migration … is very small compared to the revenues generated by maintaining the (estate) taxes.” Maine’s estate tax brought in an average of nearly $46 million in revenue over the past five years.

Worrying budget outlook: LePage’s willingness to sacrifice future state revenues before policymakers have had a chance to assess spending needs is one of the tax plan’s most worrisome parts. LePage’s two-year budget proposal does little to set the state on a path of spending less: His $6.57 billion, two-year spending plan is 2.59 percent larger than his last one and gives double-digit percentage increases to several cabinet agencies.

We appreciate some of the tax changes LePage proposes for Maine’s lowest-income taxpayers — refundable sales tax credits to offset the regressive impact of higher sales taxes and expanded, refundable property tax credits. And Maine’s sales tax needs to expand to more services, as LePage proposes, to match a more service-oriented economy and become a more stable revenue source.

All in all, however, the LePage tax plan is a deal that’s based on disproven thinking, has few guaranteed benefits that will be widespread and comes at too high a price.